Business Forms Chapter 5

Choosing a Form of Ownership There is no one “best” form of ownership. The best form of ownership depends on an entrepreneur’s particular situation. Key: Understanding the characteristics of each form of ownership and how well they match an entrepreneur’s business and personal circumstances

Factors Affecting the Choice Tax considerations Liability exposure Start-up and future capital requirements Control Managerial ability Business goals Management succession plans Cost of formation 5 - 3

Major Forms of Ownership Sole Proprietorship General Partnership Limited Partnership Corporation S Corporation Limited Liability Company Joint Venture 5 - 4

Percentage of Business 5 - 5

Percentage of Sales 5 - 6

Percentage of Net Income 5 - 7

Advantages of the Sole Proprietorship Simple to create Least costly form to begin Profit incentive Total decision making authority No special legal restrictions Easy to discontinue 5 - 8

5 - 9 Ch, 5: Forms of Business Ownership Disadvantages of the Sole Proprietorship Unlimited personal liability Limited skills and capabilities Feelings of isolation Limited access to capital Lack of continuity of the business 5 - 9

Partnership An association of two or more people who co-own a business for the purpose of making a profit. Always wise to create a partnership agreement. The best partnerships are built on trust and respect

Advantages of the Partnership Easy to establish Complementary skills of partners Division of profits Larger pool of capital Ability to attract limited partners

Types of Partners General partners – Take an active role in managing a business. – Have unlimited liability for the partnership’s debts. – Every partnership must have at least one general partner. Limited partners – Cannot participate in the day-to-day management of a company. – Have limited liability for the partnership’s debts

Types of Partners Two types of limited partners: 1.Silent partners – not active in a business but are generally known to be members of the partnership 2.Dormant partners – neither active nor generally known to be associated with the business

Advantages of the Partnership Easy to establish Complementary skills of partners Division of profits Larger pool of capital Ability to attract limited partners Minimal government regulation Flexibility Taxation

Ch, 5: Forms of Business Ownership Disadvantages of the Partnership Unlimited liability of at least one partner Capital accumulation Difficulty in disposing of partnership interest without dissolving the partnership Potential for personality and authority conflicts Partners bound by law of agency

Limited Partnership A partnership composed of at least one general partner and one or more limited partners. A general partner in this partnership is treated exactly as in a general partnership. A limited partner has limited liability and is treated as an investor in the business

Limited Liability Partnerships All partners in a business are limited partners. Gives the advantage of limited liability for the debts of the partnership. Does not pay taxes – income is passed through to the limited partners who pay taxes on their share of the company’s income

Corporation A separate legal entity from its owners. Types of corporations: ► Domestic – a corporation doing business in the state in which it is incorporated. ► Foreign – a corporation doing business in a state other than the state in which it is incorporated. ► Alien – a corporation formed in another country but doing business in the United States

Corporation Types of corporations: ► Publicly held – a corporation that has a large number of shareholders and whose stock usually is traded on one of the large stock exchanges. ► Closely held – a corporation in which shares are controlled by a relatively small number of people, often family members, relatives, or friends

Liability Features of the Basic Forms of Ownership Corporation Claims of Corporation’s Creditors Corporation’s Assets Shareholder’s Personal Assets Shareholder’s Personal Assets Shareholder’s Personal Assets Shareholder’s Personal Assets barrier

Ch, 5: Forms of Business Ownership Advantages of the Corporation Limited liability of stockholders Ability to attract capital Ability to continue indefinitely Transferable ownership

Average Tax Rate by Form of Ownership

Disadvantages of the Corporation Cost and time of incorporation process Double taxation Potential for diminished managerial incentives Legal requirements and regulatory “red tape” Potential loss of control by founder(s)

S Corporation No different from any other corporation from a legal perspective. An S corporation is taxed like a partnership, passing all of its profits (or losses) through to individual shareholders. To elect “S” status, all shareholders must consent, and the corporation must file with the IRS within the first 75 days of its tax year

Advantages of an S Corporation Retains all of the advantages of regular corporation: ► Continuity of existence ► Transferability of ownership ► Limited personal liability for owners

Disadvantages of an S Corporation Entrepreneurs considering both S and C status should review the impact of the decision on their companies. S corporation status is usually beneficial to start-up companies anticipating net losses because founders can use the loss to offset other income, and lower their tax bill

Limited Liability Company (LLC) Resembles an S Corporation but is not subject to the same restrictions. Two documents required: 1.Articles of organization 2.Operating agreement

Ch, 5: Forms of Business Ownership The Professional Corporation Designed for professions – lawyers, doctors, dentists, accountants and other professionals Created in the same manner as a corporation Identified by the abbreviations: ► P.C. – Professional Corporation ► P.A. – Professional Association ► S.C. – Service Corporation